TODAY’S STUDY: THE IMMENSE OPPORTUNITY IN ENERGY EFFICIENCY

United States Building Energy Efficiency Retrofits; Market Sizing and Financing Models

March 2012 (Deutsche Bank Climate Change Advisors and Rockefeller Foundation)

Executive Summary – Market Size, Climate, Employment Impact

Summary

 Scaling building energy efficiency retrofits in the United States offers a $279 billion dollar investment opportunity. The energy savings over 10 years could total more than $1 trillion…

 Scaling building retrofits could mitigate more than 600 million metric tons of CO2 per year (~10% of U.S. emissions in 2010)…

 Increased building retrofits could create more than 3.3 million new direct and indirect cumulative job years (excluding induced) in the United States economy.

Buildings consume approximately half (49%) of all energy used in the United States and three quarters of all electricity, according to the U.S. Energy Information Administration (EIA). Building energy retrofits, or the application of energy efficient or clean generation measures to existing building stock, represent a significant opportunity to save money, reduce climate impacts and generate or maintain jobs. However, the U.S. building stock is heterogeneous and the building retrofit market is actually comprised of a number of underlying market segments and sub-segments. The three main categories of segments include residential, commercial and institutional, as depicted above. The finance models and other market development strategies needed to realize energy efficiency measures at scale will vary by market segment, although a number of models and strategies can be applied in one or more segment. Due to the limitations of publicly available data at the segment level, this Market Scan does not include any information and analysis about the 21 segments within the Industrial category (not shown).

Retrofits require the replacement or upgrade of old building systems with new energy saving technology and processes. A retrofit is the physical and operational upgrade of a building’s energy consuming equipment. In this context, there are four key categories that we have identified as important to integrate into a retrofit project:

1. “New kit”: Repair, replace, and upgrade key internal equipment

2. New controls: Enable the system to operated more dynamically, with individual optimization by floor (or more granular) and appropriate schedules to be maintained

3. Integrated design: Evaluation of the cross-component impact of multiple systems be changed or upgraded

4. Active energy management (AEM): Systems to actively monitor and manage the performance of the upgraded systems and make corrections when necessary…

…The simple payback is a framework used to describe the return potential of energy conservation measures (ECMs) when installed in a building. The payback is the period of time required to recover the initial invested capital from the savings generated by reduced energy use. Investors will also pay close attention to other metrics such as the Internal Rate of Return (IRR) which evaluates the return of a project over a given period of time, incorporating the time value of money into the analysis. On a simple basis, a five year payback translates to approximately a 15% IRR over a ten year period, if cash flows are relatively consistent through the project term.

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Executive Summary – Financing Models

Summary

 Over the past few years, there have been new emerging financing structures, such as Energy Service Agreements (ESAs), Property Assessed Clean Energy (PACE), and On-Bill-Finance options, which offer significant potential to address historical barriers and achieve scale across the different market segments.

 These provide additional options beyond ESCOs, which operate primarily in government markets (which include both commercial and institutional segments).

 PACE has potential as a model for all segments, but it requires significant regulatory support and acceptance from the mortgage industry. On-Bill Finance could be utilized with enabling regulation or used as a mechanism to enhance other financing models across the three building market segments.

 In particular, we believe that the Energy Service Agreement structure offers significant near term potential to scale quickly and meet the needs of both real estate owners and capital providers in the commercial and institutional market, without the requirement for external enablers such as regulation or subsidy.

Below, we highlight the various financing mechanisms and structures potentially available for building energy efficiency retrofits. The traditional barriers facing the sector are discussed in the Financing Models section of the document. We exhibit the work of the World Economic Forum as a succinct summary of the different structures, from work on which Ron Herbst, contributing author, collaborated…

…A number of emerging firms are particularly active across the ESA and PACE structures, and we highlight the track records of participants across each category. Significant opportunity still exists to address the larger building retrofit market, which has not yet been addressed at scale, despite early traction and progress among the emerging firms.

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Implications for Policy

Many of the barriers that exist to scaling energy efficiency retrofits in the United States could be addressed through enabling local and national policy and regulation. Recent activity suggests the industry will scale independent of policy change, but we believe that an improved enabling policy environment could dramatically speed this process.

Enabling policy and regulation can be broad or targeted to specific market segments or finance models. Mandated efficiency targets, for example, could transform the industry across the board. Legislation that authorizes on-bill recovery for single family retrofits, on the other hand, would enable the development of a particular operational and financial model for a single segment. Both types of policies could play an important role in accelerating market adoption of energy efficiency. Below, we detail a framework for evaluating some of the policy solutions that might contribute to the development of these markets. Presently, the best examples of enabling policy and regulation for energy efficiency retrofits in the United States can be found at the local and state level. In New York City, for example, mandatory energy disclosure and benchmarking laws generate demand for retrofits and the NYC Energy Efficiency Corporation was created as a public-private mechanism to finance this demand. A survey of local policy innovations, which is mostly outside of the scope of this paper, should also inform policy going forward. We invite policymakers to survey existing examples of local policy innovation when designing new policies.

With respect to an enabling policy environment for overall market development, we suggest that policymakers consider the following:

1. Mandates (targets) that set comprehensive energy efficiency standards. Mandated efficiency targets, such as those that have been recently employed in China, could transform overall demand for building retrofits. They are most easily applied to new buildings, however, and generally need to be implemented through local building codes. Enforcement of standards requires particular emphasis if they are to have a material impact on market adoption. As such, this type of policy has the greatest potential to transform the market but is also among the most difficult to execute and should be managed carefully.

2. Disclosure requirements. Disclosure and benchmarking laws, such as those implemented in New York City, may provoke energy competition response from industry. As an alternative, voluntary systems such as Greenprint can play a complimentary role. The federal government can support disclosure-related initiatives, such as recent work by the Department of Energy to create a Buildings Performance Database, to enable more precise analysis of energy efficiency and create a template for disclosure to facilitate standardized reporting (See appendix for more detail).

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Policymakers should also consider methods for ensuring validity of the data used for benchmarking.

3. Leadership by example. Government can lead by example by using its existing assets (e.g. GSA properties) to test emerging financing models and prove out different approaches, as it did with the LEED standards. Individual government projects can increase the visibility of retrofits, and government assets collectively can contribute to a critical mass of demand.

4. Subsidies, incentives and guarantees to ‘de-risk’ energy efficiency investments. While challenging in the current budget environment, deal-enhancements, such as first lost reserves, credit enhancements or subordinated debt, can de-risk early finance models and support further proof of concept in near term to stimulate scale. Subsidized capital is not a long-term solution but could help catalyze private market development. State-level infrastructure investment banks are one way to do this at the state level; a ‘Green Bank’ has been discussed to play this role at the national level.

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In addition to the above, policymakers may choose to focus on policy and regulation designed to enable a specific finance or operational model for delivering retrofits. Examples of finance model-specific policies include:

• Energy Service Agreements (ESA): ESAs require relatively little additional policy support. Clarity on lease accounting classification by regulatory bodies helps expand roll-out, as described in the Appendix.

• Property Assessed Clean Energy (PACE): PACE requires significant enabling legislation to create an operational framework and to overcome resistance from existing real estate stakeholders. PACE zones must be established for commercial properties and standardized at the municipal level, as Sacramento, Miami, and Los Angeles have done or are seeking to do. Programs will likely require external administrators to coordinate them – there are examples of some city councils seeking to establish PACE programs but they face a lack of qualified applicants to utilize. Some advocates seek to gain mortgage industry acceptance via legislation, which requires another layer of regulatory design and approval.

• On-Bill Finance or On-Bill Recovery: On-bill energy efficiency finance (when the capital for up-front retrofit measures is provided by utilities) or on-bill recovery (when capital is provided by a third party, but utility bills are used to remit loan repayments by building tenants) both require utility involvement and significant enabling legislation, but may play a critical for unlocking residential market development when well-designed. Public Utility Commissions (PUCs) must put in place enabling policies or mandates, with support from local regulatory and legislative bodies as needed. The specific elements of program design – such as transference of loan obligation when residents move, or pro-rated distribution of partial payments between utilities and capital providers – require careful thought, as they may impact substantially program viability. In addition, implementation of on-bill programs requires active participation from multiple stakeholders in the public and private sector. Execution will likely vary by region, and national adoption would be accelerated by the emergence of a few pioneering local and state models.

It should be noted that the analysis above is focused on policies that facilitate private sector investment in energy efficiency.

Policies that seek to maximize or enhance the specific climate and employment outcomes of those investments, such as wage or training provisions, are considered out of scope for this document but have been addressed in other publications.

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U.S. Energy Efficiency Market Sizing

Summary

 Scaling building energy efficiency retrofits in the United States offers a $279 billion dollar investment opportunity. The energy savings over 10 years could total more than $1 trillion.

 Investments in residential energy efficiency upgrades offer $182 billion of investment potential, much of it in single family residential properties.

 Commercial real estate sectors offer $72 billion of investment potential, distributed across a variety of sub-segments.

 Institutional real estate sectors offer $25 billion of investment potential.

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Market Overview

Buildings consume approximately half (49%) of all energy consumed in the United States and three quarters of electricity consumed, according to the U.S. Energy Information Administration (EIA). Building energy retrofits, or the application of energy efficient or clean generation measures to existing building stock, represent a significant opportunity to save money, reduce climate impacts and generate or maintain jobs. However, the U.S. building stock is heterogeneous and the building retrofit market is actually comprised of a number of underlying market segments and sub-segments. The three main categories of segments include residential, commercial and institutional, as depicted below:

The following analysis represents an estimate of the total size of pre-1980 building stock within each category with retrofit strategies capable of achieving an average efficiency improvement of 30%:

• In residential buildings, there exists an investment opportunity of $182B. Such an investment would save 1,892T British thermal units (TBtus) in annual energy consumption

• In commercial buildings, there exists an investment opportunity of $72B. Such an investment would save 896 TBtus in annual energy consumption.

• In institutional building stock, there exists an investment opportunity of $25B. Such an investment would save 293 TBtus in annual energy consumption.

The size of the segments and sub-segments in each category are estimated in greater detail below. The potential climate and employment impacts of undertaking retrofits in these segments are estimated in the following section of the report…

Climate and Employment Impacts

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Summary

 Building energy efficiency retrofits can offer significant climate and employment impacts in the United States.

 Scaling building retrofits could mitigate more than 600 million metric tons of CO2 per year (~10% of U.S. emissions in 2010).

 Increased building retrofits could create more than 3.3 million new direct and indirect cumulative job years (excluding induced) in the United States economy

Energy efficiency retrofits present a large and diverse investment opportunity, as described in the previous section. The nature of the underlying work required to realize that opportunity - whether it entails better sealing of building envelopes, HVAC upgrades, increasing the reflectivity of roofs or installing sophisticated energy management systems – presents additional and potentially significant climate and employment benefits. The potential size and scope of these impacts are estimated below.

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Climate Impacts

The United States accounts for approximately 20% of world energy consumption. As noted in the previous section, buildings consume approximately half (49%) of energy consumed in the US, which is as much as the transportation and industrial sectors combined. According to the U.S. Energy Information Agency, fossil fuels (coal, oil and natural gas) supply three quarters (76%) of the energy consumed by those buildings. The combustion of fossil fuels to generate energy results in the production of carbon dioxide and other greenhouse gases (GHGs) that scientists increasingly agree is driving climate change. There is therefore a significant relationship between building energy consumption in the U.S. and global climate change.

Energy efficiency retrofits enable substantial reductions in building energy use. These measures create monetary savings, from reduced energy costs, which can be used to repay the upfront cost of the measures. The energy savings that result from retrofits also reduce fossil fuel consumption and therefore GHG emissions.

The climate impacts that would be realized from retrofitting all pre-1980 building stock with retrofit strategies capable of achieving an average efficiency improvement of 30% are significant: doing so would reduce overall CO2 emissions in the U.S. by 10%. The magnitude of potential climate benefits closely tracks the size of the relative investment opportunity per building segment:

• In residential buildings, there exists an opportunity to reduce energy consumption by 1,892 TBtu, which corresponds to an annual reduction in carbon dioxide (CO2) emissions of approximately 382.2M metric tons. This would mitigate the GHG emissions from 82 coal-fired power plants.

• In commercial buildings, there exists an opportunity to reduce energy consumption by 896TBtu, which corresponds to an annual reduction in carbon dioxide (CO2) emissions of approximately 175.3M metric tons. This would be the equivalent of emissions from 2.1M tanker trucks’ worth of gasoline.

• In institutional building stock, there exists an opportunity to reduce energy consumption by 293TBtu, which corresponds to an annual reduction in carbon dioxide (CO2) emissions of approximately 59.4M metric tons. This would be the equivalent of taking approximately 10.5M cars off the road.

The following table summarizes the potential energy savings and annual CO2 emissions reductions that could be achieved in the largest market segments of the market taxonomy presented on above…

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Financing Models

Summary

 Energy efficiency investment has been the “low-hanging fruit” for many years in the energy and climate space. However, it has proven consistently farther out-of-reach than expected.

 ESCOs, using Energy Performance Contracts, have been the largest participant in the retrofit market to date, but their activity has been limited to certain ownership categories (e.g. Municipal, Universities, Schools, Hospitals and Government or MUSH) in the commercial and institutional sectors.

 Over the past few years, there have been new emerging financing structures which offer significant potential to address historical barriers and achieve scale such as Energy Service Agreements (ESAs), Property Assessed Clean Energy (PACE), and On-Bill-Finance options.

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 PACE has potential as a model, but it requires significant regulatory support and acceptance from the mortgage industry. On-Bill Finance could be utilized in a regulatory framework or used as a mechanism to enhance other financing models.

 In particular, we believe that the Energy Service Agreement structure offers significant near term potential to scale quickly and meet the needs of both real estate owners and capital providers in the commercial and institutional market, without the requirement for external enablers such as legislation or subsidy.